Human bone marrow–derived mesenchymal stromal cells (MSCs) inhibit proliferation of activated T cells, and IFN-γ plays an important role in this process. This IFN-γ–licensed veto property is IDO-dependent. To further decipher the mechanistic underpinnings of MSC veto function on T cells, we investigated the effect of MSCs and IFN-γ–licensed MSCs on T cell effector function as assayed by cytokine secretion of T cells. Although MSCs and IFN-γ–licensed MSCs inhibit T cell proliferation, only IFN-γ–licensed MSCs significantly inhibit Th1 cytokine (IFN-γ, TNF-α, and IL-2) production by T cells. Additionally, IFN-γ–licensed MSCs inhibit T cell degranulation as well as single, double, and triple cytokine–producing T cells. Although IFN-γ–licensed MSCs upregulate their IDO activity, we found that MSC IDO catalytic function is dispensable with regard to MSC-driven inhibition of T cell effector function. Novel flow cytometry based functional screening of MSC-expressed, IFN-γ–licensed inhibitory molecules identified B7H1 and B7DC/PD1 pathways as essential effectors in blocking T cell function. Small interfering RNA–mediated blocking of B7H1 and B7DC reverses the inhibitory potential of IFN-γ–licensed MSCs on T cell effector function. Mechanistic analysis revealed that clustering of MHC and coinhibitory molecules are indispensable for the inhibitory effect of IFN-γ MSCs. Although exogenous IL-2 reverses B7H1-Ig–mediated inhibition of T cell proliferation, it does not affect the veto function of IFN-γ MSCs on both T cell proliferation and effector function. Our results reveal a new immunosuppressive property of IFN-γ–licensed MSCs that inhibits T cell effector function independent of IDO but through the ligands for PD1.